3 ‘Big Bang’ Income Stocks

Between games of pick-up basketball, one of my favorite players — killer jump shot — sidled over and asked me what he should do with an “extra” $10,000 he’d come into courtesy of a nice bonus.

[1]These are always difficult questions to answer. I’m never quite sure what kind of time horizon is involved, nor what the risk profile or tolerance is — and I sure don’t want to be the guy who causes people to lose money.

After a few minutes of discussion we agreed that the investment should go to income stocks that would provide him with a steady stream of quarterly dividend cash for at least the next 5-10 years, with a strong dividend yield north of 3%, and at a P/E ratio that sits at a 25% discount to that of the S&P 500, which stands at just under 19x earnings. After all, why not seek out what might be an undervalued play? For good measure, I’ve made it so at least one of the picks pays out its dividend in different months than the other two.

Now, before we get to the list, I’ll admit the thought of taking a bit of a flyer with “found” money crossed my mind. Dan Burrows suggested that doubling up on some current winners[2] could pay out well, and any of the the three he suggests could be worth the gamble. However, I might look at biotechnology giant Amgen (AMGN[3]). The company is at the forefront of genetically based research for cancer, anemia and other illnesses; it pays a dividend (unlike most biotechs); and it trades for just under a 20x P/E multiple.

But if safety and security is what we’re looking for — and that was a ground rule — let’s look at three I’ll present to my sharp-shooting colleague. See what you think:

Chevron

Dividend yield: 3.19%

P/E: 10

It’s hard to go wrong with an oil and gas play, despite the ups and downs found in the energy sector, and Chevron (CVX[4]) is one of the proven winners in the field.

CVX operates in both the upstream exploration and extraction of oil and gas reserves, and downstream distribution and marketing for those products, so they’ve got both primary sides of the business covered.

Like everyone else, Chevron is investing heavily in finding new sources of both oil and gas, tapping markets in in Africa, Australia and and China, all the while working domestic production sites including those in the Marcellus shale fields in Pennsylvania, Ohio and West Virginia. Those new global areas are expected to increase oil production by 1% over the next year (2014) and up to 5% over the following four years, according to Dividend Growth Investor estimates[5].

Despite some up-and-down earnings over the past three years and massive capital expenditure spending to spur future growth, the coffers are hardly bare: Chevron sat on $20 billion in cash at the end of fiscal 2012, and pumped out nearly $40 billion in net operating cash flow. With a payout ratio sitting at an almost miserly 30%, CVX should easily extend its 26-year consecutive year streak of increasing dividends for the long term, providing income in March, June, September and December.

Lockheed Martin

Dividend yield: 3.50%

P/E: 15

Defense contractor Lockheed Martin (LMT[6]) warned last year[7] at the outset of the sequestration fight it might be hurt by defense industry cutbacks. If that’s the case, you’d be hard-pressed to find that result in its financials.

Indeed, while its revenue growth over the past year (FY 2011-2012) came in at just under 2%, earnings growth was better at 3% despite the initial round of cuts during the year. As for 2013, second-quarter earnings came in 10% higher compared to last year’s similar period, despite a 4.3% decline in revenues.

The company was bullish enough to raise its full year forecast by 40 cents per share, again despite looking at the possibility of another round of defense cuts. Lockheed is in a position where it can cut expenses — mostly personnel — fairly dramatically if programs are shelved or cut, helping to manage expenses on each project.

Lockheed’s profitability drives that fiscal year-end balance sheet, which showed nearly $2 billion in cash, and cashflow, which stood at $1.6 billion at the end of 2012. The company has raised its dividend over the last 10 consecutive years, and I would expect that to continue, with payments also coming out in March, June, September, and December.

Cisco

Dividend Yield: 2.78%

P/E: 13

I’m not the only fan of networking and communications giant Cisco (CSCO[8]): Jeff Reeves recently penned a recommendation[9] for the stock based on its most recent dividend increases, low payout ratio, and solid dividend yield.

I’m with him on all counts, and would add steady growth along the bottom line over the past three years despite a slowdown — but not lower — growth along the top line. Indeed, Cisco is making moves to try and boost that top line, most recently through the acquisition of security software provider Sourcefire (FIRE[10]), along with its nearly $225 million in revenues. The company still owns around 60% of the data-networking market, and is an entrenched cloud player and as Tom Taulli writes[11], up and coming mobile force. In another words, these guys are well positioned for the future.

Cisco sits on around $50 billion in cash and short-term securities, and net operating cash flow of just under $13 billion, it has plenty of room to improve on its 33% payout ratio. Cisco started paying a dividend in 2011, and it’s making up for lost time: 183% dividend growth since the dividend inception, including a very healthy 21% boost on the last go-around. I would expect more of the same for a long time to come. Cisco pays out its dividends in January, April, July and October.

Marc Bastow is an assistant editor at InvestorPlace.com. As of this writing he did not hold a position in any of the aforementioned securities.